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11/19/2006

Milton Friedman--Posner's Comment

I knew Milton Friedman, but not well; and I am not competent to express an informed opinion on his major academic work, which was in macroeconomics. The economists of his generation with whom I principally associated were George Stigler, Ronald Coase, and Aaron Director (Friedman's brother-in-law)--microeconomists who had a major impact on the law and economics movement.
I did, however, read a few of Friedman's essays. Two in particular struck me around the time I came to Chicago. One was his essay on the methodology of positive economics, in which he argued that the way to test a theory was not by assessing the realism of its assumptions, but by assessing the accuracy of its predictions. Economics makes heavy use of unrealistic assumptions, primarily concerning rationality, and yet the predictions generated by models based on those assumptions are often accurate. Where they are inaccurate, this is a spur to reexamining the assumptions and perhaps modifying them, as is occurring in such fields as finance, where assuming a more complex human psychology than finance theorists traditionally assumed has helped to explain anomalies (from a rational-choice perspective) in the behavior of financial markets.
The emphasis on predictions connects Friedman's essay to Karl Popper's philosophy of science, in which the scientific method is viewed as a matter of making bold hypotheses, confronting them with data, and ascribing tentative (always tentative) validity to the hypotheses that survive the confrontation. Popper's methodology of fallibilism has strong affinities with Friedman's methodology. Both are strongly empiricist. Stigler in conversation merged these two closely related approaches, and I was very struck by the melded approach.
The other essay of Friedman's that struck me was an essay on taxation in which he argued, contrary to the conventional view at the time (though I gather the argument was not original with him), that there was no theoretical reason for supposing income taxes superior in point of efficient resource allocation to excise taxes. An excise tax--say, a 10 percent tax on yachts--drives a wedge between cost and price and so deflects buyers to substitutes that may cost more to produce but look cheaper because they are not taxed at so high a rate. (The effect is the same as monopoly pricing.) But Friedman argued that income taxes have the same effect, by driving a wedge between the cost of work and the wage (price) received by the worker, thus deflecting him to untaxed substitutes, such as leisure, or to jobs that generate untaxed benefits, including leisure in the case of teaching (for example), but also prestige, amenities, tax-favored fringe benefits, and job security. This idea of the parity of excise and income taxes has wide-ranging implications for public policy, since the tendency (still) is to neglect the misallocative effects of income taxation--a neglect of which I think even Friedman was sometimes guilty, as I am about to argue.
Perhaps his most important general contribution to economic policy was the simple, but when he first propounded it largely ignored or rejected, point that people have a better sense of their interests than third parties, including government officials, do. Friedman argued this point with reference to a host of issues, including the choice between a volunteer and a conscript army. With conscription, government officials determine the most productive use of an individual: should he be a soldier, or a worker in an essential industry, or a student, and if a soldier should he be an infantryman, a medic, etc.? In a volunteer army, in contrast, the determination is made by the individual--he chooses whether to be a soldier or not, and (within limits) if he decides to be a soldier what branch, specialty, etc., to work in. A volunteer army should provide a better matching of person to job than conscription, and in addition should create a more efficient balance between labor and capital inputs into military activity by pricing labor at its civilian opportunity costs.
But this is in general rather than in every case. The smaller the armed forces and the less risk of death or serious injury in military service, the more efficient a volunteer army is relative to a conscript one. These conditions are not satisfied in a general war in which a significant fraction of the young adult population is needed for the proper conduct of the war and the risk of death or serious injury is substantial--the situation in World War II. For then the government's heavy demand for military labor, coupled with the high cost of military service to soldiers at significant risk, would drive the market wage rate for such service through the roof. Very heavy taxes would be required to defray the expense of a volunteer army in these circumstances and those taxes would have misallocative effects that might well exceed the misallocative effects of conscription.
I mention this example because I find slightly off-putting what I sensed to be a dogmatic streak in Milton Friedman. I think his belief in the superior efficiency of free markets to government as a means of resource allocation, though fruitful and largely correct, was embraced by him as an article of faith and not merely as a hypothesis. I think he considered it almost a personal affront that the Scandinavian nations, particularly Sweden, could achieve and maintain very high levels of economic output despite very high rates of taxation, an enormous public sector, and extensive wealth redistribution resulting in much greater economic equality than in the United States. I don't think his analytic apparatus could explain such an anomaly.
I also think that Friedman, again more as a matter of faith than of science, exaggerated the correlation between economic and political freedom. A country can be highly productive though it has an authoritarian political system, as in China, or democratic and impoverished, as was true for the first half century or so of India's democracy and remains true to a considerable extent, since India remains extremely poor though it has a large and thriving middle class--an expanding island in the sea of misery. What is true is that commercial values are in tension with aristocratic and militaristic values that support authoritarian government, and also that as people become economically independent they are less subservient, and so less willing to submit to control by politicians; and also that they become more concerned with the protection of property rights, which authoritarian government threatens. But Friedman seemed to share Friedrich Hayek's extreme and inaccurate view that socialism of the sort that Britain embraced under the old Labour Party was incompatible with democracy, and I don't think that there is a good theoretical or empirical basis for that view. The Road to Serfdom flunks the test of accuracy of prediction!
I imagine that without the element of faith that I have been stressing, Friedman might have lacked the moral courage to propound his libertarian views in the chilly intellectual and political climate in which he first advanced them. So it should probably be reckoned on balance a good thing, though not to my personal taste. His advocacy of school vouchers, the volunteer army (in the era in which he advocated it--which we are still in), and the negative income tax demonstrates the fruitfulness of his master micreconomic insight that, in general, people know better than government how to manage their lives. But perhaps not always.

Comments

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"For then the government's heavy demand for military labor, coupled with the high cost of military service to soldiers at significant risk, would drive the market wage rate for such service through the roof."

So? Just because defense is a public good doesn't mean the lives of potential conscripts are too.

"Very heavy taxes would be required to defray the expense of a volunteer army in these circumstances and those taxes would have misallocative effects that might well exceed the misallocative effects of conscription."

Better to conscript and send people to die than to tax them? Easy to say that when you're not the one being conscripted. And what, exactly, is the marginal rate of substitution between death and taxes? How exactly would you propose measuring it, either theoretically or empiracally?

"I don't think that there is a good theoretical or empirical basis for [Friedman's] view."

Let's be fair to Hayek (and simply honest) -- Britain abandoned many of the things Hayek most worried about, often _because_ of what Hayek wrote. And it is clear that the British left did listen to Hayek, and did adjust their thinking due to his arguments. (This is also true of America, as the historian Alan Brinkley has pointed out.)

Hayek says he wrote his book _The Road to Serfdom_ to change history and Hayek believes his book did change how history came out -- and a number of historians back Hayek up on this.

Hayek wasn't making a prophecy or a prediction -- he was intervening to change history. Hayek, I shouldn't have to tell you, was not a Marxist. Hayek didn't believe in historical inevitability and he believed arguments and ideas could change history.

I'm wondering if you've actually read Hayek -- your many comments over the years on the ideas of Hayek lead me to believe you haven't read his actual writings, only misleading or false accounts of Hayek's actual thoughts and arguments. Am I right?

Let's be fair to Hayek (and simply honest) -- Britain abandoned many of the things Hayek most worried about, often _because_ of what Hayek wrote. And it is clear that the British left did listen to Hayek, and did adjust their thinking due to his arguments. (This is also true of America, as the historian Alan Brinkley has pointed out.)

Hayek says he wrote his book _The Road to Serfdom_ to change history and Hayek believes his book did change how history came out -- and a number of historians back Hayek up on this.

Hayek wasn't making a prophecy or a prediction -- he was intervening to change history. Hayek, I shouldn't have to tell you, was not a Marxist. Hayek didn't believe in historical inevitability and he believed arguments and ideas could change history.

I'm wondering if you've actually read Hayek -- your many comments over the years on the ideas of Hayek lead me to believe you haven't read his actual writings, only misleading or false accounts of Hayek's actual thoughts and arguments. Am I right?

Posner: "Very heavy taxes would be required to defray the expense of a volunteer army in these circumstances and those taxes would have misallocative effects that might well exceed the misallocative effects of conscription."

In short 'I want my wars, but perish the thought of high taxes on *me*. Never should I suffer even one-tenth of what peasant draftees should be made to suffer.' According to: http://en.wikipedia.org/wiki/Richard_Posner, it looks like Posner is another right-winger who never found it necessary to serve his country.

If wars, by law, led immediately to higher taxes on the rich, I bet that the USA might discover diplomacy again. Force would be used by the USA only when necessary, not when desired.

In discussing Friedman, Posner identifies a pervasive problem in the political debate today. Many modern conservatives believe as a matter of faith in the superiority of unregulated markets and private industry. They ignore the reality that some regulation (though certainly not all regulation) provides beneficial results. Indeed, "think tanks" funded by corporate money propogate the faith by singing the praises of deregulation in every industry and by advocating tax breaks for the corporate class. Unfortunately, most citizens are unaware of the conflicts of interest that underlie such advocacy. And, many politicians have their own conflicts of interest, because the same corporate money funds their compaigns.

FYI - In a recent update of Free To Choose, Milton Friedman softened his views on the connection between democracy and capitalism and pointed toward China as an example of a country that (so-far) has managed to be an outlier.

I think Posner is guilty of creating a Straw Friedman. He accepted the possibility of needing total mobilization for a WWII type of war for national survival. In Capitalism and Freedom he accepted universal military training for just such a contingency.

At any rate, today we are a nation of 300 million people, with about 50 million in the prime soldiering ages 18-30. There's no way we could have an army that size. And then the Hayek of The Use of Knowledge in Society becomes very important.

Friedman's own contribution to WWII is very instructive too. He was part of Allen Wallis' Statistical Research Group at Columbia.

Friedman actually was used as a consultant during the Battle of the Bulge to explain the math behind the settings on proximity fuses for air bursts against German ground troops. Army officers flew into Washington DC and then went back to the battlefield and put into action what they'd learned.

Jeffrey Sachs misreads Hayek just as Judge Posner misreads Hayek. This letter that I sent last month to Scientific American -- which published Sachs's misinterpretation of Hayek -- applies also to Judge Posner's misinterpretation:

6 October 2006

Editor, Scientific American

To the Editor:

Jeffrey Sachs writes that the late "Friedrich Von Hayek was Wrong" ("Welfare States, beyond Ideology," November 2006). This Nobel laureate's error allegedly was to argue that the welfare state paves - as the title of Hayek's 1944 book expressed it - "the road to serfdom."

Sachs misreads Hayek. Although he was no fan of the welfare state, Hayek never argued that it leads to tyranny. In The Road to Serfdom, Hayek distinguished between government efforts to ensure "limited security" and government efforts to achieve "absolute security." Hayek warned only against efforts to achieve the latter, which he described as "the security of a given standard of life, or of the relative position which one person or group enjoys compared with others." Hayek was correct that such "security" is achievable only by tyranny.

But as for limited security, Hayek wrote that "There is no reason why in a society which has reached the general level of wealth which ours has attained the first kind of security [that is, limited security] should not be guaranteed to all without endangering general freedom‚Ä¶. Nor is there any reason why the state should not assist the individuals in providing for those common hazards of life against which, because of their uncertainty, few individuals can make adequate provision" [pages 133-134].

"A country can be highly productive though it has an authoritarian political system, as in China, or democratic and impoverished, as was true for the first half century or so of India's democracy..."

Neither of these observations contradicts Friedman in any significant way. Considering, first, the China example, remember that Friedman admired Hong Kong for its immense economic accomplishments under a British colonial rule that happend to give great economic freedom with little political freedom.

India's history merely illustrates that one can have democracy with very little economic freedom. Indeed, if the US had intended to retard India's emergence as an economic power, a dozen nuclear bombs would have been less effective than sending them Ambassador John Kenneth Galbraith to teach them how to run a properly socialist economy.

If there's any refutation of Friedman to be found in India, it would be that Friedman's thesis of political freedom depending on economic freedom is inconsistent with India's political freedoms surviving so well and so long in the absence of better economic freedoms. But I don't think you were trying to make that case.

Poser says: I also think that Friedman, again more as a matter of faith than of science, exaggerated the correlation between economic and political freedom.

Something is wrong in what Posner says, I don't know what it is.

As a matter of fact there is a strong relationship between Economic Freedom and Development, Economic Growth. Better the economic growth better the development thereby higher standard of living for the common man.

Plain political freedom achieves nothing. What is the use of political freedom if I have to live below poverty line for my whole life due to lack of economic freedom. But wait, even in India Political freedom had to depend upon Economic freedom. In 1991, India had very very less economic freedom even though is had political freedom, it averted becoming a total collapse and insolvency by liberalising its economy, otherwise all hell would have broken loose.

India would have become like another african state with civil war and warring tribes.

Poser says:protection of property rights, which authoritarian government threatens.
People in India do not have any property right, so does it make it Authoritarian or a Politically free nation??
Even in the US of A there is 'Eminent Domain', does this law protect property right??.
Is America Authoritarian as it threatens property rights??

Poser says:The Road to Serfdom flunks the test of accuracy of prediction!
I wish Posner should have lived in germany under nazi rule or atleast in Soviet Russia or under Mao in China.

Greg: that the left in Britain listened to Hayek suggests that his initial argument wasn't strictly correct. For the mechanism in RTS to work, planners have to prefer authoritarianism to free markets. Planning has to have value over and above anything else, otherwise we get a retreat from planning prior to the rise of the demagogue. If the British left found persuasive Hayek's argument that a planned economy was inconsistent with democratic freedom, and chose the latter rather than the former, they also gave evidence against the RTS mechanism. Planning led to serfdom really only where planning was initiated by those already non-benevolent; where it started with largely benevolent planners, we instead saw a retreat to the welfare state.

Hayek was not opposed to a welfare state, he was opposed to the notion that the government could plan the economy. The original understanding of socialism was that government planning would out-perform the chaos of markets. Britain started to become socialist in this sense, but then became more of a welfare state. Hayek was arguing that the socialist idea, in the sense of a commitment to a planned economy, if followed, would result in tyranny. Something like this happened in India in the 1970s, at which point India began to back down from socialist planning. The case of India, as well as much of the communist world, validates Hayek. If a thorough-going socialist party had actually insisted on socialism, rather than large welfare states, we would have seen more of the pathologies suggested by Hayek (whose rhetoric in TRS was admittedly less nuanced than it should have been, but whose logic still had a certain validity).

I agree ... a misreading of Hayek and a misleading description of Sweden (lets see Sweden maintain its current situation as birth-rates decline and the Ponzi scheme of pay-as-you-go pensions and unemployment insurance unravels -- also - Sweden has no defense budget and is homogeneous.)

The last part of Posner's comment brings to mind (for both Friedman and Hayek) Schumpeter's distinction between "Marx the Economist" (a source of many valuable insights) and "Marx
the Prophet" (wrong, as I think Hayek was in RTS, but in this role bringing the kind of vigor and vision needed to get one's ideas adopted--for good or ill).

In regards to Sweden. There seems to be confusion here regarding the taxation. It is true that taxes on consumers and wage earners is very high. Not so on production however. Business taxes are rather moderate. Sweden‚Äôs socialism was not a socialisation of production but of consumption. It is meant to control consumers and force them to spend their funds the way the government wishes. For businesses, especially those in export, the situation is not much different than other well off nations. So when you mention the high taxes it is a bit odd since the high taxes are not on the production which you then mention but on the consumption which you don‚Äôt mention.

I noticed that schizophrenic tendency in Friedman as well. I agree that theory based on shaky assumptions should be judged by its predictions, not the shaky assumptions. But then arguing for policy changes based on a theory not specifically tested in the relevent area or case is absurd. You can't have it both ways. Either your assumptions behind the theory you want to apply need to be rock-solid, or you need specific empirical evidence.

You refer to Popper but then violate his principle of falsifiability. You praise Friedman for a great theory but say that it needs to be tested. Do you have an alternate theory that does not need to be tested. I think that the proposition that Sweden's system could work as effectively in any country is more likely to be falsifiable than Friedman's theories. Same with Britain's policies. And both could yet fail. Friedman's theories could also fail but they have stood up better than any other.

But like he implied, in the absence of all other theories being falsified, you have to go with the ones left standing. Since condition A is unattainable, Friedman's prescription is just as good as Sweden's.

Friedman liked to compare the relative performances of the economies of West Germany and East Germany as the closest thing one could come to a controled experiment, proving the superiority of market economies over socialism. But Friedman ignored the fact that West Germany was not an example of the kind of laissez-faire capitalism he advocated, but, rather, a welfare state, similar to, though to a lesser degree, Sweden, with, among other things, universal health insurance.

Also, on the conscription topic. If Germany had been living by Friedman's principles, there never would have been a war, or a holocaust in the first place. You can't fault his prescription by throwing up an example in which they weren't being applied.

Until all countries go with volunteer armies, unnecessary and irrational wars will continue to be waged, but that is more an affirmation than a negation of Friedman's views.

The basic tenet of Friedman's version of monetarism was that the velocity of money was stable, or at least predictable, so that to stabilize the economy one merely had to keep the rate of growth of the money supply constant. This turned out to be totally incorrect. Friedman at one point even advocated passing a constitutional amemdment requiring the Fed to keep the rate of growth of the money supply at a constant rate. Fortunately he did not get his way because the effect of this would have been disasterous on the economy.

(My criticsms should not be misinterpreted, I think Friedman made very important contributions to economics and deserved the Nobel Prize. But there are important areas where he was mislead by his ideological blinders.)

Economic and political rights do go hand in hand. The reason for the inequality and lack of freedom in China and India is not because they have economic rights without political rights, but because they have economic rights only selectively applied. In India, there are only certain industries and regions that are economically free. The same with China, which is why rural China is still so poor.

China's high rate of growth is not evidence of economic freedom decoupled from political freedom. They still have little economic freedom...the only reason the country is growing is because they have MORE freedom (very little) than they did (zero). Without ever more economic freedom, that growth will stop.

Captain Video, why is Friedman's monetary theory incorrect? He never said the velocity of money was perfectly stable, he said that IF it is stable then the government can stabilize the economy by controlling the money supply (either growing it or not growing it). I think most economists would agree that this holds up, certainly the Central Bankers do.

If you are saying that it is merely hard to measure the velocity, that doesn't weaken his theory.

He argued that it was actually stable enough, or at least predictable enough, so that having the money supply grow at a low constant rate would stabilize the economy. He very strongly advocated that such a policy be followed, to the point of supporting a constitutional amendment requiring the government to do this.

The fact that velocity turned out to be very unstable and unpredictable did orthodox monetarism in.

Obviously, if velocity were stable, such a policy would work. Few would dispute this point, but this theoretical tecnicality was not what monetarism was all about.

Check his writings on economic policy and you will see that I am right. Unfortunately I do not have the time to dig through the material and come up with quotations at the present time.